El Salvador | Capitulation

Siobhan Morden | March 11, 2022

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The price floor in the $50s last month on El Savador’s Eurobonds quickly came under pressure with Russia’s invasion of Ukraine. The debt now trades in deeply distressed territory in the $40s and closer to Argentina and select Russian corporate credits than other ‘B’ credits like Ghana and Pakistan.  This looks more like a divestment trade than an accurate reassessment of fundamentals.

Our scenario remains steady with breakeven prices in the $50s based on low $30s recovery value, payment of the 2023 Eurobond and mudding through until the 2025 amortization. The near-term financing should rely on a combination of multilateral loans and local debt. But risk is higher for 2025 unless the Bukele administration pivots towards fiscal discipline or Bitcoin creates financing and growth dividends.

The latest external shock hits El Salvador’s fundamentals on two fronts – its status as an oil importer and its access external capital.  These shocks are particularly important for low-rated credits with the least policy flexibility and no access to the International Monetary Fund as the lender of last resort.  El Salvador is a net oil importer, similar to the rest of Central America.  It’s relative oil dependence ranks closer to the top of the pack with fuel at 14% of total imports and 6.5% of GDP. There is some flexibility on external flows thanks to still high workers remittances, high foreign exchange reserves and a recovery in tourism.

For bondholders, the concerns focus primarily on the competition between bond payments and fuel subsidies on the budget cashflow constraints.  The 2022 budget outlines fuel subsidies at 1.9% of total spending or 0.54% of GDP.  The price shock of a 50% increase in fuel prices would not be overly burdensome at 0.24% of GDP if absorbing the full impact of the price increase. President Bukele just announced a battery of measures to diffuse the price shock on consumers.  The suspension of select fuel taxes for two months would affect the budget by a mere 0.06% of GDP. There were no estimates for lost import taxes on select consumer goods. The total subsidy burden at worst increases from 0.54% of GDP to 0.84% of GDP. There were no announcements on how to fund these subsidies. However, there is significant budgetary flexibility with the 2022 budget forecasting total spending at 27% of GDP against the pre-pandemic levels of 20% of GDP in 2019.

The latest oil shock may not have much if any impact on El Salvador’s financing program with the country already cut off from Eurobond markets and mostly restricted access to multilateral funding markets.  The recent resiliency of Bitcoin and perhaps renewed demand as a byproduct of Russian sanctions may still motivate the volcano bond (BTC-linked) issuance.  There was a roadshow in Europe last week, and President Bukele tweeted reaffirmation of the release of the finance regulations for next week. The digital securities bill represents the critical framework for the volcano bonds. The ability to launch innovative financing under current unstable market conditions would provide some financing flexibility.  The intended funds are related to Bitcoin city. However these funds are fungible on a potential re-prioritization of spending.

The timeframe for default is critical with bond prices a breakdown of $30 low recovery value and the around three years of coupon payments through the 2023 amortization and up until the next 2025 amortization. The markets are now unwinding the probability of repayment on the 2023 with bond prices off 7 points in the past three weeks and most of the bonds trading below the breakeven returns of repayment up until 2025.

The willingness to pay is also critical.  Will officials prioritize debt payments? The recent communication continues to include the 2023 Eurobond amortization in the funding program with not even a slight deviation or admission of default risk. The default of the Eurobond’2023s isn’t their game plan, running contrary to their plans to issue bonds with hybrid Bitcoin and El Salvador risks and converting San Salvador into a global Bitcoin financial center. If seeking international prestige and legitimacy, then why would the Bukele administration validate rating agency warnings and other skeptics of bad policy management.  The “willingness to pay” at this stage seems quite strong with still options in the early phase of cashflow stress. Minister Zelaya continues to reiterate the commitment to pay and lays out different scenarios to source funds through the January 2023 Eurobond payment.

The latest investor communication still shows the IMF as Plan A for their $4.8 billion gross financing program. However the economic team is now showing other financing alternatives on its commitment to honor the 2023 Eurobond amortization. These alternatives rely upon a favorable domestic market for $2 billion rollover of CETES/LETES, the $500 million disbursement of already approved multilateral investments (CABEI, WB) and another $360 million of pending multilateral loans. The other financing options include $500 million from CAF, $200 million from CABEI and either $900 million in internal sources that’s mostly pension funds or a combination of drawdown of treasury deposits or IMF SDRs. This sounds feasible on muddling through on the early stages of cash flow stress with current prices uncertain about near-term liquidity options and no optionality to pivot towards either fiscal discipline or BTC-related financing and/or growth options. The successful launch of the volcano bond may provide some near-term reassurance on liquidity risks.